Basel liquidity rule may be watered down amid crisis concerns

End-of-the-year deadline looms

Global banking regulators will this week seek to resolve clashes over how far to ease a planned liquidity rule, amid calls for the standard to be watered down and delayed because it may thwart economic recovery.

Regulators face an end-of-the-year deadline to revamp the draft liquidity coverage ratio, or LCR, criticized by top officials such as European Central Bank President Mario Draghi for threatening to choke interbank lending. The Basel Committee on Banking Supervision will try to find a compromise as it meets in the Swiss city on Dec. 13-14.

“If the LCR doesn’t come together next week into a consensus standard with credible prospects for EU and U.S. implementation -- a very iffy proposition, -- the concept of global liquidity standards will collapse,” Karen Shaw Petrou, managing partner of Washington-based Federal Financial Analytics Inc., said in an e-mail.

While Draghi and Bank of England Governor Mervyn King have urged caution on the LCR, other regulators and central bankers including Stefan Ingves, the Basel committee’s chairman and governor of Sweden’s Riksbank, claim there is no hard evidence of damaging side-effects. U.S. and German supervisors also argue that heavily diluting the LCR, scheduled to become binding in 2015, risks rendering the standard meaningless.

Basel III

The LCR would force banks to hold enough easy-to-sell assets to survive a 30-day credit squeeze. It’s a key component of a package of capital and liquidity measures, known as Basel III, drawn up to avoid a repeat of the 2008 financial crisis.

The rule sets out a stress test that banks should apply to their books, assessing whether they would be able to generate enough cash from asset sales to meet their obligations.

One conundrum facing regulators this week is how far to expand the list of assets that banks can use to meet the LCR compared with a 2010 draft, said three people familiar with the negotiations, who asked not to be identified because the talks are private.

The negotiations will discuss whether banks should be allowed to use asset-backed securities as part of their efforts to meet the standard, two of the people said.

Banks have advocated a wide expansion in the list of eligible securities, saying that a failure to overhaul the standard would force them to cut back lending.

Asset Range

“In practice, there are a range of assets that can provide liquidity,” said Mark Bearman, a director at the Association for Financial Markets in Europe, said by e-mail. These include “equities, high quality securitizations, gold and other commodities.”

The same applies to other assets that central banks accept as collateral, Bearman said. AFME represents international lenders including Deutsche Bank AG, BNP Paribas SA, and Goldman Sachs Group Inc.

While there is only limited support on the committee for including gold or equities in the LCR, views are more evenly divided on the question of asset-backed securities, two of the people said.

The 2010 draft version of the LCR largely limits the assets that banks can use to meet the standard to cash and government bonds. It says highly rated corporate debt and covered bonds could count toward bank’s LCR buffers, with a cap of 40 percent in most cases.

The Basel group is also weighing whether to delay the rule past 2015 or start a phased rollout in that year, said one of the people. The panel could also opt to proceed with the previous schedule.

Potentially Fatal

While some regulators favor a delay, other authorities are concerned that such a step could be fatal to the LCR, as it would give reluctant countries further opportunities to kill the rule off entirely, said another person familiar with the talks.

A sample of 209 banks assessed by the Basel committee had a collective shortfall of 1.8 trillion euros ($2.3 trillion) at the end of 2011 in the assets needed to meet the LCR, according to figures published by the Basel group.

Regulators are set to reduce the severity of the stress scenario that banks will be pitted against in the LCR, one of the people familiar with the talks said.

Central banks including the ECB have also warned that the LCR could make it harder for them to implement their monetary policies, as banks wouldn’t be able to offer their highest quality assets as collateral.

The Bank for International Settlements, which houses the Basel committee, said on Dec. 9 that while the LCR won’t “impair central banks’ ability to implement monetary policy,” they may need to “adjust their operational frameworks to better fit the new environment.”